Cyprus: A Eurogroup deal that is painful but more just than before

2013-03-25

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In the early hours of March 25, the eurogroup has reached an agreement on the macroeconomic adjustment programme for Cyprus, which is in my humble opinion more just than the previous deal that placed asymmetric losses on small depositors while not touching senior bondholders when dealing with the downsizing of the banking system. The new agreement focuses at the heart of the problem, namely Cyprus’ two mega-banks, Popular (Laiki) and Bank of Cyprus; and the decisions agreed upon will lead to measures that will greatly diminish the size of these two banks that now comprise the largest part of the domestic banking system. The agreement of the Eurogroup includes the following:

Laiki will be resolved immediately – with full contribution of equity shareholders, bond holders and uninsured depositors – based on a decision by the Central Bank of Cyprus, using the newly adopted Bank Resolution Framework.

Laiki will be split into a good bank and a bad bank. The bad bank will be run down over time.

The good bank will be folded into Bank of Cyprus (BoC), using the Bank Resolution Framework, after having heard the Boards of Directors of BoC and Laiki. It will take 9 bn Euros of ELA with it. Only uninsured deposits in BoC will remain frozen until recapitalisation has been effected, and may subsequently be subject to appropriate conditions.

The Governing Council of the ECB will provide liquidity to the BoC in line with applicable rules.

BoC will be recapitalised through a deposit/equity conversion of uninsured deposits with full contribution of equity shareholders and bond holders.

The conversion will be such that a capital ratio of 9 % is secured by the end of the programme.

All insured depositors in all banks will be fully protected in accordance with the relevant EU legislation.

The programme money (up to 10bn Euros) will not be used to recapitalise Laiki and Bank of Cyprus.

It is crystal clear that the government of Mr. Anastasiades had no option of attempting to save foreign deposits and salvage Cypriot-Russian relations at the expense of spreading the costs to small depositors. This plan was already rejected in the domestic parliament and was denounced by everyone as manifestly unjust.

What is now the case, is an aggressive stratagem to address the heart of Cyprus’ economic woes, its two mega-banks, in a way that involves the resolution of the zombie-bank, Laiki, together with a mixture of bail-ins of uninsured depositors, shareholders and bondholders for the Bank of Cyprus. The direct cost for the failure of these two banks will be borne by those who had a stake in the matter, notwithstanding the far-reaching indirect losses that the rest of the people will suffer in terms of capital controls and other arbitrary political decisions.

In moral terms, the positive aspect of this agreement is that the Augean stables of the Cypriot banking system are now being decisively cleansed, by virtue of an independent and thoroughgoing audit, in an effort to determine whether anti-money laundering legislation was hitherto enforced or not. The audit will allow for all the graft and corruption to be unearthed, so that we may finally find out the extent of the symbiotic relationship between Cyprus’ mega-banks, the local political establishment and foreign plutocrats.

The eurogroup’s agreement, if approved, shall inflict a great deal of harm on Russian interests; on Russian depositors at first and, perhaps second, on Russian geo-economic ambitions. Russian money will contribute to the restructuring and downsizing of the Cypriot banks, while Russia’s government seems to have been unable to effectively force Cyprus out of the EU, in its attempt to bring it under its own sphere of geo-strategic influence. What remains to be seen henceforth, is the Russian reaction, which on the one hand will involve Russian plutocrats abandoning Cyprus in favor of other havens for their (ill-gotten?) gains/assets, while on the other it will feature a change in orientations for Russia’s foreign policy, as Cyprus will now be regarded as a de facto “European” state or protectorate rather than as a potential Russian satellite.

With the economic links between Cyprus and Russia being severed, it is not clear how will the Russian government be able to strengthen its presence in the region, especially after accounting for the numerous financial, technical and diplomatic difficulties inherent in the exploitation of the gas reserves south of Cyprus.

As for the capital controls that were voted in the Cypriot parliament a few days ago, for them not to become counter-productive and cause asymmetric pain on the real economy and the lower and middle parts of the income distribution, it must be made absolutely certain that these measures be temporary, proportionate and strictly non-discriminatory. Ideally, if one could use such a word at these hours where only suboptimal options are available, capital controls must not last more than the time necessary to receive the first tranche of the bailout funds.

Ever since Greece first received a bailout back in 2010, it was well known to everyone, except the self-deluded Cypriot political elite, that Cyprus would have suffered this fate as the speculative and unsustainable bubbles of the pre-crisis era would have to burst, and their end-product, the over-sized banking system, to be decisively downsized. With the eurogroup’s new agreement, this readjustment will occur in a manner that is least bad, under the prevailing circumstances. However, contrary to many of my fellow commentators on Cyprus, I will once again repeat that most of the hardships that Cypriots will have to endure, are the fault of the domestic political class, which:

first, insisted for decades on instituting the banking system as the central pillar of the economy, supported by the narrative of Cyprus becoming an omniptent financial centre,

second, welcomed, endorsed and facilitated the capital inflows from abroad, without considering the quality of those deposits/investments and, moreover, by arrogantly dismissing the long-term deleterious effects the bubble economy would cause,

third, attempted to bound up together the financial system with its geo-strategic ambitions, manifested in the exploitation of the natural gas, without considering the rights of a substantial part of the Cypriot population, the Turkish-Cypriots, and without showing any genuine sentiment of consensuality necessary in solving the Cyprus problem, before adding additional controversies over it,

fourth, its unwillingness to take proactive yet radical measures to address the malignancies of the domestic zombie-banks, before these banks could create the black holes that now need to be filled up with good money; one such black hole being the Emergency Liquidity Assistance (ELA) funds that Laiki absorbed from the Central Bank of Cyprus, despite the fact that it was evidently insolvent, and hence the decision to provide it with liquidity must be denounced as totally irresponsible and opportunistic.

Without prejudice to the aforementioned, it ought to be stressed that Cyprus will experience changes in a number of fields whose ramifications cannot yet be fathomed in their totality. Some of the key issue that practically beg to be examined involve the following:

The credibility of the domestic banking system has been shattered and will require several years to recover,

Cypriot-Russian relations have taken a turn for the worse, however this will affect the geo-strategic balance in the broader region; and it seems that Cyprus has now made a tacit but clear choice to align with the EU and be distanced from Russia’s sphere of control,

The intentions of the Greek-Cypriots regarding the Cyprus problem have again been revealed, and it has been evident that these are not at all the kind of orientations and sentiments that would foster an honest series of negotiations for finding a solution to the Cyprus dispute. The South showed, with cavalier smugness, that it considers the natural gas as its own property, or more accurately, as the fief of those shaping the Greek-Cypriot political aspirations and of the large corporate interests that are woven together with them (see the second part of my previous article on this).

More shall follow as the Memorandum of Understanding with the troika is brought into being and as other economic or geopolitical actors react to what is taking place in Cyprus and the Euro area. Let us hope that in the meantime no more inane decisions, which could jeopardize everything, will be taken. Brace yourselves…

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